The breakdown of a marriage is one of the most challenging issues a family can endure. It tends to be very tense, which can cause tax planning to be overlooked. It is important to know the rules so the total farm assets and cash flow being divided is maximized.
In most cases, divorce will result in the splitting up or repurchase of farmland and assets. It is important to consider several questions:
- Was there a pre-nuptial agreement that will be followed for the divorce?
- What farm assets were received as a gift or inheritance? Do you have promissory notes outstanding?
- How many non-farming assets can go to the exiting spouse to keep the farm together?
- Is the majority of the farm value in a corporation? Will you pay dividends, buy the shares or split the farm corporation into two for the divorce settlement?
- Does the exiting spouse have the lifetime capital gains exemption available?
Regardless of the decision on how to split assets, there could be tax consequences. There are elections that can be used to minimize tax, but this typically must be done before the divorce is legally finalized.
Your home is another asset that cannot be easily divided. The sale of your current home and the purchase of two new houses may be required. Generally, if an asset is sold for more than you bought it for, taxes must be paid on the gain. However, tax rules allow for Canadian taxpayers to sell their principal residence tax free.
Only a single house may be designated as a principal residence per family unit. However, if separated or divorced throughout the year, each spouse can have a separate principal residence.
The breaking up of the family unit is often the hardest part. Unfortunately, how the family is structured post-divorce will have an impact on taxes:
- Child support payments are not deductible from the payer’s income and are not included as income for the partner who receives the payment.
- Spousal support payments are taxable. The partner receiving the payment will pay tax on payments received. If certain requirements are met, the payer can deduct this amount from taxable income.
- Another consideration is claiming children as dependents. A child cannot be claimed as an eligible dependent more than once. Also, the person paying child support cannot claim children as dependents. If you have two or more children, the divorce agreements may be structured so each spouse can claim a child as a dependent.
- With child-care expenses, the lower income spouse rules no longer apply and both partners are permitted to deduct these costs.
Points to remember
Divorces can invoke feelings of contempt and bitterness, but understand that co-operation can minimize the tax cost for both sides. It is best to speak to your adviser as early as possible because they can help you explore all options and assist you in finding the most favourable solutions.
The author would like to thank Hayley Hilz and Robert Mercer of KPMG for their assistance with writing this article.
Colin Miller is a chartered accountant and partner with KPMG’s tax practice in Lethbridge. Contact: firstname.lastname@example.org.